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Litigation Costs for Unreasonable Penalty Recovered

In Mitchell, (TC Memo 2000-145), the Tax
Court awarded a taxpayer litigation costs attributable to an
accuracy-related penalty after finding it was not reasonable for the
IRS to impose such a penalty.

In the original case ( Mitchell, TC Memo 1999-283), the
issue was the rule in IRC section 162(a). Under it, for costs paid or
incurred after 1992, a taxpayer away from home for a period of
employment that exceeds one year generally is not treated as being
temporarily away from home and cannot deduct travel expenses.

The taxpayer was a self-employed consultant who worked out of a home
office in Chicago. From 1991 through 1995, he was busy on a number of
projects for one client. Each assignment lasted one year or less. He
did some of the work at his home office, but frequently traveled to
California and worked there for the client for extended periods of
time. He stayed in a rented apartment in California for 155 days
during 1994 and 113 days during 1995. During these projects, he was
free to work for other clients.

The IRS disallowed the taxpayer’s travel expenses for 1994 and 1995
and claimed the taxpayer’s tax home had shifted from Chicago to
California because of his extensive work there. It said that because
the taxpayer worked for a single client in California for at least
five years, the work violated the one-year rule in IRC section 162(a).
In addition, the IRS imposed an accuracy-related penalty under section
6662.

The Tax Court allowed all the disputed deductions, holding that the
taxpayer’s stays in California did not violate the one-year rule,
because he was not employed there continuously on one project for more
than one year. The court said that just because an independent
contractor returns to the same general location over a period of a
year or more does not mean he or she is employed there on an
indefinite basis.

After the taxpayer won, he petitioned the Tax Court for litigation
costs under IRC section 7430 on the grounds that the IRS’s position
regarding the travel expenses had not been substantially justified.
But the court’s decision was mixed. It held that the IRS’s position on
the travel expenses was not unreasonable, because the case was the
first in which the one-year rule was invoked as it applied to
independent contractors. But the court also found the IRS had been
unreasonable in imposing an accuracy penalty because it was a case of
“first impression” involving the unclear application of a code
amendment.

The court determined that the taxpayer was reasonable and had acted
in good faith in taking a position on his travel expenses, so the
accuracy penalty did not apply. Therefore, it awarded the taxpayer the
portion of litigation costs that was related to the accuracy penalty.